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The Battle for Value in Smart Contract Platforms

WOM B&W
Will Ogden Moore
  • In the Smart Contract Platforms Crypto Sector, value accrual is a flywheel that connects fees and network usage with token valuation and the security and decentralization of a network.
  • Networks within the Smart Contract Platforms Crypto Sector take different approaches to compete for fee revenue: some pursue it with relatively high transaction costs, while others seek to capture more volume with relatively low transaction costs.
  • Grayscale Research believes that fee revenue can be considered the primary driver of value accrual for tokens in this market segment, although other fundamentals are important to monitor as well, as they can influence fee revenue over time.
  • While sector leader Ethereum has several years of established network fee revenue generation (over $2bn in 2023), other smart contract platforms like Solana are also demonstrating maturation (~$200mm so far in 2024).[1]

There is a common misperception that crypto assets have no fundamental value and cannot be analyzed like traditional investments. Grayscale Research believes this is simply not true. Smart contract platforms like Ethereum and Solana, for example, generate fee revenue from the economic activity that takes place on their networks. Grayscale Research believes that one way an investor can value assets within the Smart Contracts Platforms Crypto Sector is through their ability to generate fee revenue over time.

Smart Contract Platform Fundamentals

Smart contract platforms like Ethereum and Solana are networks where developers can build decentralized applications ranging in nature from gaming to finance to NFTs. The role of a smart contract blockchain is to process the transactions of the applications it serves in a manner that is secure and resistant to censorship.

As a result, the value of a smart contract platform is intrinsically related to the activity on its network. Key indicators of a network’s activity include the amount of transactions it can process, the number of users it can support (typically measured by daily active addresses); the value of assets it supports, known as total value locked (TVL); and the network’s ability to monetize its blockspace, or network fee revenue—more on this later.

Each of these metrics tells a story. For example, Ethereum’s lead in TVL ($66bn, over seven times larger than the next competitor) illustrates its liquidity advantage and value proposition for financial applications (Exhibit 1).[2] In addition, its advantage in the total number of ecosystem applications creates network effects towards attracting new developers, applications, and users. Meanwhile, Solana’s number of daily transactions—emblematic of its throughput advantage and low cost—position its chain better for high-volume use cases like DEPIN[3] and retail-friendly use cases like NFTs and memecoins.

In addition to comparing and contrasting these fundamental metrics across assets, investors can put these numbers in the context of market capitalization, or where the market currently values a particular asset. For example, as seen in Exhibit 1, while Solana’s TVL ($4.7bn) is currently greater than Arbitrum’s ($3.2bn), Arbitrum’s Market Cap-TVL ratio (1x) is substantially less than that of Solana (16x). These metrics allow investors to not only gain a view of the relative strengths and weaknesses of different assets but also help them uncover value as well.

Exhibit 1: Smart contract platform fundamentals[4]
(bolded signifies largest fundamental metric in peer set)

The Central Role of Fees

Still, while there are many different ways to measure network activity, theoretically and empirically, the most important single fundamental variable for a smart contract platform valuation is network fee revenue (Exhibit 2). This metric can be thought of as the aggregate amount of fees paid by users to use the network. Smart contract platforms have many different revenue models, but ultimately need to generate fees in order to deliver value to token holders.

Similar to centralized entities in traditional industries, there are different ways for decentralized networks to compete for fee revenue. For example, some smart contract platforms pursue fee revenue with relatively high transaction costs, while others attempt to capture more volume with relatively low transaction costs. Both approaches can be effective. Consider two hypothetical blockchains:

Example Chain 1: Small amount of users and transactions, high cost per transaction

5 users, 10 total transactions, $10 per transaction

            Network fee revenue = $100

Example Chain 2: Large amount of users and transactions, low cost per transaction

100 users, 100 total transactions, $1 per transaction

            Network fee revenue = $100

This illustrative example shows that, despite the fact that Chain 2 has substantially more users and total transactions, both chains generate the same amount of network fee revenue. While measures like users and transactions are also important, they need to be considered alongside transaction costs, because this will determine fee revenue.

The importance of fee revenue holds empirically, as well as conceptually. For example, Exhibit 2 shows the relationship between fee revenue and market capitalization (in log scale) for components of our Smart Contract Platforms Crypto Sector. Although crypto markets are still maturing, investors already differentiate across projects based on fundamentals. Analysis by Grayscale Research shows that the relationship between fee revenue and market cap is relatively stable over time, and that fee revenue more correlates to market cap than other measures of smart contract platform fundamentals.[5]

Exhibit 2: Network fee revenue is most closely correlated with market cap

Grayscale Research believes that one reason there is a close relationship between fees and market cap partly is because of how critical network fee revenue is for token value accrual. Value accrual means that protocols structure their tokens in a manner that links network activity with the long-term sustainable value of that token. Different stages of value accrual can be found through the following three examples: Ethereum, Solana, and Near.[6]

Ethereum: The “Premium Chain” with Proven Value Accrual

The first and largest smart contract blockchain by market cap, Ethereum, started to face serious questions regarding scaling in 2022. Increased usage led to congestion in the network, which made transactions expensive for users: its average daily network fee reached highs of $200 per transaction on May 1, 2022.[7]

However, increased usage and the high average transaction fees also translated to significant value accrual, as Ethereum generated over $2bn in total network fee revenue in 2023.[8] Network fee revenue on the Ethereum network consists of two parts: the base fee and tips. Every time a user pays for a transaction, the base fee is “burned,” removing Ether supply from the network. At the same time, tips paid to prioritize transactions are given out as rewards to validators and stakers helping secure the network.

As a result, this massive amount of Ethereum network revenue in 2023 led to 2mm Ether tokens (ETH) being burned (1.7% of supply), accruing value to ETH holders, and also $390mm in rewards to validators and stakers, incentivizing greater levels of network security.[9]

Ethereum has reached a stage of maturity where it has proven its ability to generate value accrual. On Ethereum’s mainnet, users pay a premium cost for a premium productin this case, blockspace that is backed by the smart contract platform with the largest amount of network security. This is particularly relevant for applications that involve large transaction values and prioritize network security, such as stablecoins or tokenized financial assets. This level of maturity in its ability to monetize its users is reflected in its valuation, at $458 billion (as of June 6, 2024), almost six times larger than any other smart contract platform.[10]

Exhibit 3: Increase in network usage (reflected in periods of greater supply burn) tend to correspond with higher valuation

Solana: The “High-Performance Chain” That Is Figuring Out Value Accrual

While Ethereum has one model to capture fee revenue, Solana takes a different approach, and has recently made progress in narrowing the gap with the market leader. Solana, the second largest smart contract platform by market cap, has long been thought of as a faster, cheaper alternative to Ethereum, with impressive speed (335 transactions per second) and low cost ($0.04 per transaction on average).[11] However, in previous years, it was unable to translate this to fee generation. In 2023, despite the fact that Solana processes significantly more transactions, it generated just $13mm in network fee revenue versus Ethereum’s $2bn (154x less).[12]

In the past, this lack of value accrual has reflected a relative disadvantage for Solana; however, in 2024, this has been changing. Year to date, Solana has already generated six times the fees it had from all of 2023, closing the fee gap between Ethereum and Solana from 154x in 2023 to 16x (Exhibit 4). This indicates that the Solana model—low transaction costs and high throughput—can also help generate economic value.

Exhibit 4: Solana has started to figure out value accrual with its fees

Notably, this substantial increase in fee generation has coincided with a large gain in market cap.[13] This dramatic increase in network fee revenue generation is largely attributable to a significant increase in average transaction fees (up 37x versus last year) rather than an overall increase in transactions (up only 33% versus last year).[14] Ironically, this increase in average fees for the chain traditionally known as the “cheap option” comes at the same time that Ethereum Layer 2 transaction fees have decreased due to Ethereum’s Dencun upgrade (Exhibit 5). Since April 1, the average transaction fee for users on Solana ($0.04) is still cheaper than on Ethereum ($4.80) but more expensive than on Layer 2 Arbitrum ($0.01). [15]

Exhibit 5: ETH’s Dencun upgrade led to cheaper Layer 2s; increase in fees has helped Solana figure out value accrual


Because Solana has become more expensive on a per transaction basis to its users than Ethereum Layer 2 Arbitrum, it potentially risks some of its positioning as the go-to cheap, high throughput chain. Despite this, Grayscale Research believes that overall this increase in fees is a net positive development because 1) it reflects high levels of user activity, and 2) it indicates value accrual to stakers and token holders. 

Near: Proven Adoption in Onboarding to Crypto but Early in Network Monetization

These two prior examples are contrasted by Near, a smart contract platform that has recently gained significant adoption from non-speculative use cases but has yet to demonstrate value accrual. Near is the underlying platform for KaiKai and Hot Protocol, the two largest decentralized applications (dApps) by users in all of crypto. Near leads all smart contract platforms with 1.4mm daily active users and is competitive in throughput with the fastest chains in the sector such as Solana (Exhibit 6).

Exhibit 6: Near leads all smart contract platforms in daily active users

Despite leading the pack in users, Near is still far behind competitors in user base monetization, with only $4.1mm generated in fees year to date.[16] This indicates that it is currently in a relatively less mature phase of development, which is also represented in its valuation relative to competitors ($7.9bn market cap versus $458bn for Ethereum and $78bn for Solana).[17] While the Near network has shown an ability to process transactions at a high rate, it is not currently delivering the amount of value accrual to token holders or stakers that would indicate a valuation at the level of its larger competitors.

Despite its relative inability thus far to monetize, Near’s substantial adoption serves as an important starting point. If the network is able to either continue to scale network adoption or increase average transaction fees without reducing network activity (similar to Solana’s recent progression), it could realize meaningful value accrual.

Each of these three smart contract platforms—Ethereum, Solana, and Near—represent different stages of maturity in network fee revenue generation of a decentralized network. Ethereum has multiple years of revenue and growth. Solana has a history of a strong user base but has only just started to generate substantial revenue. Finally, Near has shown traction with its product, in part due to low costs, but has not yet shown meaningful revenue.

Caveats and Nuances on Fees and Valuation

To be sure, there are a number of caveats and nuances on fees and valuation in the Smart Contract Platforms Crypto Sector. For one, every protocol involves different forms of value accrual and various rates of token emission (inflation) and token burn (deflation). In cases of tokens with a high inflation rate, the impact of value accrual from fees may be significantly diluted by token emissions. Each protocol has its own fee structures. On Ethereum, transaction fees contribute to token burn, benefiting all token holders, while priority fees are allocated to validators and stakers. On Solana, the distribution differs: 50% of transaction fees are burned and the remaining 50% go to stakers. Recently, a governance vote determined that 100% of Solana's priority fees will be directed to validators.[18] These policies reflect Solana’s larger validator hardware requirements. In addition, high levels of MEV[19] activity on Solana provides additional rewards to validators and stakers and acts as an “indirect” cost to token holders. Consequently, general token holders accrue more value from Ethereum’s fee structure, while Solana’s validators and stakers do so on Solana.

Similar to how a valuation of traditional assets might involve future cash flows discounted back to the present, the valuation of a crypto asset also could involve future expected network fees generation discounted back to the present. This variable accounts for future potential growth in adoption, usage, or monetization of a particular network in a manner that is distinct from current overall fees generated today. For example, one could rationalize that Ethereum’s valuation of $458bn is pricing in not only its current amount of fee generation but also its potential to take advantage of its network effects and grow Layer 2 adoption, usage, and fee revenue generation in the future.

Lastly, the valuation of certain crypto assets may include a “money premium.” In other words, users may be willing to hold the asset for its functions as a money medium—as a medium of exchange and/or store of value—above and beyond the network’s ability to generate fee revenue. For Ethereum in particular, the concept of a money premium may be important for considering its valuation (especially if the token becomes widely used as a collateral asset across the industry).

Conclusion

If value accrual is properly implemented into a protocol, an increase in network usage incentivizes users to not only hold a token, taking it out of circulation and potentially boosting its value, but also to be a validator or stake tokens, helping improve network security. In addition to network security, fees incentivize more validators to come online, resulting in greater levels of decentralization and censorship resistance. As a result, value accrual is a flywheel that connects fees and network usage with token valuation and the security and decentralization of a network. 

While it is important to acknowledge that fees can serve as an indicator of the level of maturity of a network, there are many other elements of this flywheel that can influence the growth of a network and its valuation. For example, if a particular application takes off in adoption, that could lead to more users, attracting more developers to build within the same ecosystem. As a result, network fees should be viewed within both the context of the other fundamental metrics and the context of the relative valuation of a particular ecosystem (market cap).

Going forward, it will be important to monitor some of these growth stories. Can Ethereum continue to grow its fees on the mainnet despite relatively high average transaction costs for users ($4.80) through use cases with high-value transactions like tokenized financial assets? Can Ethereum grow its fees with increased Layer 2 activity? How will Solana straddle the line between monetization and keeping its chain low-cost enough so it doesn’t lose users to other cheap, high throughput chains? Will Near attempt to monetize or will it continue to forgo meaningful levels of fee revenue generation while prioritizing the growth of its user base?

These dynamics underscore the importance of monitoring fundamental metrics including fees, transactions, active users, and TVL. Grayscale Research believes that as the crypto asset class continues to mature with increased adoption, the importance of these fundamental metrics will continue to grow as well. These metrics will provide deeper insights into the relative strengths and opportunities within the Smart Contract Platforms Crypto Sector—ultimately helping to guide informed investment decisions by fostering a more nuanced understanding of network value.


[1] Artemis

[2] Artemis, data as of 6/6/2024

[3] Decentralized Physical Infrastructure Networks like Helium or Render, both on the Solana network.

[4] Ordered by top 20 by market capitalization as of 6/6/2024

[5] We ran an analysis of the correlation between the annual average of daily fundamental metrics and the annual average of daily market caps for each asset in the Grayscale Smart Contract Platforms Crypto Sector. Fundamental metrics we tested against market cap included transactions, daily active users, TVL, and fees. We performed this analysis from 2022 through 2024 year to date and found, in each case, that fees correlates most closely with market cap.

[6] Assets chosen as illustrative examples of different stages of value accrual maturation.

[7] Artemis

[8] Artemis

[9] Glassnode

[10] Artemis

[11] Artemis, monthly averages as of May 26, 2024.

[12] Artemis

[13] Artemis, as of May 26, 2024

[14] Artemis, as of May 26, 2024

[15] Artemis, as of June 6, 2024

[16]  Artemis, as of May 26, 2024

[17]  Artemis, as of May 26, 2024

[18] Crypto Slate

[19] Maximum Extractable Value (MEV) is the highest profit a blockchain miner or validator can make by reordering, including, or excluding transactions within a block.

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